I have just realized that I have been rattling on about High Frequency Trading ( HFT) without justifying why they should be subject to a World Aid Commission of 0.05%.

I have and still do advocate that the vast accumulation of wealth and political power” that is currently undermining democracy in the west must be caped in order to contribute to the world as a whole and not just the rich.(See previous Postings on Sovereignty Wealth Funds, Foreign Exchange Transactions and High Frequency Trading.)

The stock market has become a virtual space – an interactive, computer-driven system of staggering complexity. An Illusory Market. In many ways we’ve all become vassals again.

Why do I call it an Illusory market. Because the market that the investor sees when he looks at his monitor, is anywhere from 1,500 to 900 milliseconds old. That doesn’t sound like much, because the blink of an eye is 300ms. But that’s a long, long time in the world of HFT.

HFT have been around as long as computer systems have been in our lives.

As computers get more technically advanced, trading practices have increased in size and algorithms have become more sophisticated. The trades are done at close to the speed of light. Remarkably, HFT firms have moved their server farms near an exchange computer to further increase trading speeds.

The objective of HFT is to take advantage of minute discrepancies in prices and trade on them quickly and in huge quantities. Algorithms trade on price movements past a certain threshold, corporate actions, price ceilings, price floors, and discrepancies in bid/ask spreads. The trades are executed without any human action except for initial programming.

In most cases, the trades are executed before individual investors know the quotes of prices, or that the trades happened at all. For instance, a computer recognizes when one exchange quotes an ask price of one cent more than the quote on another exchange. This computer then trades in extraordinarily large volumes on this information, taking advantage of the arbitrage opportunity in a split second. Before individual and other investors who do not possess the same sophisticated technology realize, the one-cent spread between the two exchanges is erased and the stock price trades at the same level. There are entire hedge funds devoted to this strategy.

Managers pool capital based on a proven computer technology and allow the program work for them. In addition, large trading shops incorporate these HFT strategies as part of their overall practice. Such large volumes of HFT trades are being executed that most of the liquidity in daily trading is a result of these trades. By some estimates, HFT makes up 60 to 70% of all trades done in the US on a daily basis and 40 percent in European markets.. Other estimates project that if these strategies keep proliferating at their current rate, 80% of trades will be HFT trades by 2015.

It would be naive of me to think that we could stop using HFT purely for morality’s sake. When large amounts of money stand to be made any Morality goes out the door.

When an algorithm is processing information, this last one doesn’t consider if its actions will have consequences for third parties; the only target is to make money, it is totally irrelevant as what is happening around. Whether it is fleecing the public – the ordinary savers and workers with pensions is the least of its worries.

It is Greed personified.

High Frequency Trading Profitability Potential

Trading Frequency

Average Maximum Gain per period

Range Standard Deviation per Period

Number of Observations in the Sample Period

Maximum Annualized Sharpe Ratio*

10 Seconds

0.04%

0.01%

2,592,000

5,879.80

1 Minute

0.06%

0.02%

43,200

1,860.10

10 Minutes

0.12%

0.09%

4,320

246.40

1 Hour

0.30%

0.19%

720

122.13

1 Day

1.79%

0.76%

30

37.30

*The Sharpe ratio is also called the Reward-to-Variability Ratio. It measures the excess return per unit of risk.

The above chart shows the potential for higher returns exists based on the strategy alone. In fact, the Sharpe ratio is over 200% higher for the 10 second trading frequency than for the 1 minute frequency.

Perhaps it is naive to believe that morality should even come into it.

O! by the way when you are bidding on those Internet Auctions site you are up against bid sniper software, which is placing bids on items milliseconds before auctions ended.